I started my career in the mail-room of a Wall Street firm. The dirtiest job I had was to load the brokers’ gunpowder for presentation kits. The printing machines, almost as big as my car and definitely more expensive, ran all day long.
I took scuba tank sized containers of this black powder, and wobbled them around to try and jam into place. Several misfires later, I looked like a coal miner at the end of re-fill days. Other days I would take mountains of those printed pages and bind them together in thick pitch-books, always with glossy covers. Manufactured confusion was, and still is, a booming business on Wall Street.
That was in 1996. I still wish gloss was a commodity to buy on a futures exchange. Now, I own an independent investment firm. Purposefully, we tore down a dive bar across the street from an elementary school to construct our building. Dad to 5 kids, I like investing in our neighborhood and schools in many ways (more on that later).
One of our founding principles is the slick brochure rule. When you find one, there is something to be sold, not bought. So, we have none. I look back fondly at my ten-year career working inside the belly of the beast of the world’s largest bank/brokerage at the time, because I learned so much. Before any owner’s manual can be written, as many possible experiments to test what does not work need to be complete. The best parting gift was to remain curious and never convinced.
“The greatest obstacle to discovery is not ignorance. It is the illusion of knowledge.”
By the time I left Wall Street, the pages of legal disclaimers being printed at the end of clients’ research reports were longer than the research. They kept inventing new products with so many layers, some I did not even understand as a Senior Portfolio Manager. Gladly leaving behind a lot of stock options and bonus offers, I was not smart enough to know exactly how their credit crisis would start unraveling the very next year in 2007, but I knew there were problems and wanted to vote with my feet. Better to start from scratch after learning that clients do not want all those confusing pitch-books. They really only have two questions.
Am I going to be okay?
How much is enough?
That’s it. If you can answer these two questions, clearly, then you will have a gift most will never know – peace of mind. From all the strategies I examined, I learned the only hedge needed is humility.
Complexity is the enemy of executing any plan. If I had to boil down into one sentence what I am most grateful for learning, that would be it. But, that does not mean you are looking for what is easiest either. The Holy Grail for mastering any craft is deeply informed simplicity. After studying every page of every single one of those pitch-books for years, I came to a simple conclusion that would have been impossible without the benefit of all that confusion. And here it is – according to my math anyhow – NONE of what we need to execute an efficient plan has been created by Wall Street since anybody reading this was born. That took me a long time, and half a career of process by elimination, to realize.
The final presentations I made before leaving showed how the wealth managers’ (they didn’t like to be called brokers anymore) customers can go broke with withdrawal rates lower than rates of return. I even spotted them the very best results they could hope for. You may have guessed by now that I was not terribly popular with this crowd. I chose an unrivaled growth mutual fund track record during the 1980’s. The best in the business. There was only one time I recall this famous manager stepping outside his stock-picking batter’s box to share numbers for income planning. He suggested withdrawing 7% per year from a portfolio was sustainable for retiring. For starters, he dismissed the notion of owning bonds at all since stocks outperform them over time. So, with 100% of a nest egg invested in funds yielding an average of 3% dividends and generating 8% from capital gains, his projected average annual 11% total return was more than enough to pull 7%, he explained to Wall Street.
Start with any sized nest egg. I’d ask any group if they made an average of 11% then subtracted 7% annually, after thirty years, what would it be worth? Their answers were always huge numbers, every single time. That is what the best mind inside the country’s leader in retirement assets recommended. What could possibly go wrong?
When you are living off that nest egg rather than adding to it, then average rates of return no longer matter. The ACTUAL returns each year wreak havoc on these plans. All I had to do was walk them through one of the recent 30-year periods where that withdrawal strategy took any nest egg to $0, less than half way through. Big losses hurt more than big gains help. It does not matter how great a track record could be, if you run out of money before you get there.
“One of the great tragedies of life is the murder of a beautiful theory
by a gang of brutal facts.” -Benjamin Franklin
Projecting total returns and applying a withdrawal rate that you hope is conservative enough is…hoping. Plenty of retirement plans can work just fine this way, don’t get me wrong…until something goes wrong.
Wondering if I am going to be okay is a normal person’s way of saying – save the volatility jargon, confusing charts, and new Frankenstein funds designed to help me sleep better (that would give you nightmares if you knew what was inside some). Just tell me how this all works if something bad happens. Am I going to be okay?!
Here is the first simple step of our answer. Know exactly how much of your nest egg is COMPLETELY removed from harm’s way. Not low risk, I mean no risk. How much do you have in: Cash, CD’s, Treasuries, and Insured Deposits?
And, do not let them add any gloss on top.
“A man is rich in proportion to the number of things he can afford to let alone.”
–Henry David Thoreau
One of those types of insured deposits is called an insured Tax-Free Municipal Bond. Last I checked with the St. Louis Federal Reserve, the percentage of U.S. households that directly own individual bonds of any kind is down to 1%. Inside that gigantic market of all bonds, it is a fraction of a fraction that own insured Tax-Free Municipal Bonds in their own accounts. Now, compare that to my unofficial survey of approximately 99% of households who would rather pay less in taxes and/or who worry about risk. You will start to understand why this is the most astounding investment contradiction I have ever witnessed.
Yields on those bonds are lower now than some times in the past, so they are less tempting for many. Not me. It is the same reason my kids know we eat broccoli before chocolate cake. “We gotta do what we need to do, before we do more of what we want to do.” They can roll their eyes in unison by now. Beautifully boring risk-free assets are the broccoli that many investors give too many reasons for skipping these days. I am reminded every day when I look across the street from my window at that elementary school what will not change. A Tax-Free Municipal bond was issued to build the school and many others in the district, and we bought them. We will buy more, and in other districts. The Permanent School Fund of Texas has been around since 1854 insuring every penny of those bonds are paid in full.
“The best time to think about losing is when you are winning.” –Casey Stengel
To be clear, I am not talking about bond funds or fixed income alternatives or anything in a pitch-book. Broccoli does not get healthier the deeper it is stuffed in cheese casseroles that your crazy aunt smothers it in. Unlike an individual bond, funds have no maturity date promising when you will get all of your money back. Fund values can fall from trading losses when rates rise. When leverage and derivatives are added inside bond funds and fixed income products, they can do worse than fall.
Far more common than any market disaster’s impact on a nest egg is a conspiracy that robs investors in plain sight every day – excessive fees. I looked up one of the largest bond mutual funds to make my point as hard to defend as possible. One of the original ideas with mutual funds was as they increase in size, the same cost of doing business is spread among more customers whose expenses should then go down. So, the largest funds should have considerable cost advantages. I found this popular one cost 1.43% last year. At the time of this writing, the risk-free 20-year Treasury yield is about 3%, a good benchmark to compare any decisions you are willing to pay to actively manage around. So, you are counting on incredible bond trading profits to justify paying almost HALF the risk-free rate of return in a horse race for higher total returns. The co-conspirator of disappointing results is anybody who bets with the crippling math of high fees.
In fairness, mutual fund investors have no idea what they sign up for, even if they are thoroughly informed and willing to read the entire fund’s prospectus. They would find in this case, the annual fund management expenses to be 0.67%. Following SEC rules, mutual funds do NOT disclose what their annual transaction costs ON TOP of that misleading figure are. Even the most sophisticated investors believe their “total expenses” may be less than half of what they actually are. The fund cannot disclose the trading costs ahead of time because they have no idea what they will be until the year is over. The only clue an investigative investor has, in order to take a guess, is looking at past turnover rates. This large fund happened to run at 291% annual turnover. Bonds, no different than stocks, cost a fund money every time they are traded. Customers never see that invoice and have no clue what the final number will be, but have already signed their name to an open tab.
“The greatest trick the devil ever pulled was convincing the world he did not exist.”
An individual bond, held directly in your own account, has a maturity date showing exactly when you get your principal back after years of receiving interest payments as well. The default rate of AAA-rated general obligation insured tax-free municipal bonds has been 0.00%. Municipal bonds have been around for more than two centuries. No Wall Street product or fund has that kind of track record.
There are many more interesting ways to make a lot more money than these bonds. But consider a hidden relationship between defense and offense when investing. If you know you have a set amount of your hard-earned nest egg (start with ANY amount) completely removed from harm’s way, you may find that peace of mind is key to unlocking even more of opportunity’s doors with the rest. That way even when you’re wrong, you know for certain you will still be okay.
Click here for part 2 of the two questions we all have: How Much is Enough?
On Twitter @RyanKruegerROI